SEC Challenges Delaware’s Strong Anti-Takeover Law

Federal regulators argued Thursday that a Delaware state law giving broad takeover protection to more than half of the nation’s largest public companies violates the U.S. Constitution.

In a friend-of-the-court brief filed in U.S. District Court in Delaware, the Securities and Exchange Commission argued that the state takeover law enacted in February frustrates the intent of federal law governing tender offers, a common method of purchasing corporate control.

The brief supports a suit filed earlier this month by Tate & Lyle PLC, a British firm currently offering $1.3 billion for U.S. sugar producer Staley Continental Inc., to invalidate the Delaware law. Staley has rejected the bid.

In general, the Delaware law prohibits mergers or similar business deals for a three-year period between a company and a holder of more than 15% of that company’s common stock.

Exceptions to the law include shareholders who acquired a 15% stake in a board-approved transaction, or holders whose stake rose from less than 15% to more than 85% in a single transaction.

Public companies that elect to be covered by the Delaware law include 56% of the U.S. Fortune 500 companies and 45% of companies listed on the New York Stock Exchange, the country’s most prestigious exchange.

Delaware has long been a haven for corporate basing because of its Legislature’s favorable stance toward businesses, which may incorporate in the state even if they have no operations located there.

Helps “Vest Management”

Federal law governing stock purchases through tender offers makes clear that shareholders should be allowed the freedom to decide whether to sell their shares in a tender offer, the SEC argued.

But the Delaware law works to “vest management, in many instances, with decisive power over the effectuation of business transactions (such as mergers) that are critical to many tender offers,” the SEC said.

“The Delaware law thereby effectively gives management substantial power to determine which tender offers shareholders can consider, a result contrary to the free shareholder choice” promoted by federal law, the SEC said in a prepared statement.

Because it frustrates the purpose of existing federal law, the state law is unconstitutional, the SEC argued.

The Delaware law also violates the commerce clause of the Constitution by restraining interstate commerce in securities and corporate control “far in excess of what is required to promote any legitimate state interest,” the SEC argued in the brief.

Move Applauded

A spokesman for the United Shareholders Assn., created by Texas oilman T. Boone Pickens Jr. to fight against entrenched corporate management, applauded the SEC’s decision to support Tate & Lyle’s challenge to the Delaware law.

“We’ve held all along that the law is unconstitutional, so we’re glad to have the SEC on our side of the argument,” United Shareholders spokesman Pat McGurn said.

“It looks like its a good case. It’s one where they have made all of the right arguments,” McGurn said. “This is the one that has the best shot of making it through.”

Whether the SEC’s brief will be given much weight by the court remains to be seen, but McGurn said the SEC’s expertise and history of challenging state laws may give it influence with the court.

While the U.S. District Court in Delaware is expected to soon issue a preliminary decision on the validity of the state law, the wait for a definitive decision via appeals courts could be lengthy, McGurn said.